WaPo Delivers a Much-Needed “Wait a Second”

The economy faces a long, hard path to any real recovery

With all the positive talk about the economy in the press over the last couple of months, you’d think happy days are almost here again. Don’t bet on it. In fact, bet against it, if you must.

The press has a built-in tendency toward short-term thinking and it sometimes succumbs to it. If the economic indicator reverses course, it’s news. If the economic indicator continues to trend down or trend up, it’s not quite as newsy. Recently, economic indicators have improved (or not been as pitiful) and the coverage has reflected this.

But we have to remember the big picture. Recall that we have trillions of dollars of bad assets sitting in the system that will take years and years to work out. Housing is getting ever worse, despite some positive signals on prices and sales, and commercial real estate is cratering. We’ve spent or pledged trillions of dollars to clean up the financial mess and that has to be paid back at some point. Economic activity is being propped up by massive government spending, which can’t continue indefinitely. The financial system is hugely dependent on the emergency programs from the Fed and Treasury. Confidence in the system is pretty well shattered, which will weigh on risk-taking for years (though, admittedly, that may well be countered by all the moral hazard introduced by the bailouts).

So it’s welcome to see the Washington Post’s Neil Irwin pour water on the case for a speedy recovery.

Huge swaths of the financial system have been damaged, which could lock consumers and businesses out of loans for years to come. American families are saving more and relying less on borrowed money. In this global recession, no part of the world appears poised to lead a buoyant recovery. And the U.S. government’s aggressive stimulus efforts — including special Federal Reserve lending programs and full-throttle government spending — may need to wind down before the economy returns to solid footing.

The story even comes with a handy metaphor: The economy is a rubber band. Pull it back a lot (deep recession) and it usually snaps back with a strong recovery. But, this “downturn may be so severe, global and transformative that this time, the rubber band popped.”

The WaPo gives us good reason why this is so. Historical context on the aftermath of financial calamities, which are far different than normal recessions.

Downturns caused by financial crises play out differently. The machinery of the financial system grinds to a halt; people cannot get credit to buy things and businesses cannot borrow money to expand.

According to an analysis of 14 financial crises around the world by economists Carmen M. Reinhart and Kenneth Rogoff, the unemployment rate rises an average of seven percentage points in a downturn (this one has increased the U.S. jobless rate by only 4.7 percentage points), and the crisis lasts an average of 4.8 years (this one is at the two-year point).

This is great stuff, but it’s left hanging with no comparison. These numbers should have been accompanied by numbers for the typical recession or, better yet, numbers for the average recession not caused by a financial crisis.

But that’s something of a quibble (and something of a personal hobbyhorse). Most of the rest of the piece is sharp.

There’s talk of the crippled shadow-banking system, which accounted for so much of pre-crisis lending, but now exists (what remains of it, anyway) largely because of the Fed’s backstops. Most of that, lending funded by CDO’s and the like, will not and should not come back.

Which raises a tangential question: How much of the lending that’s actually occurring right now is due primarily to the extraordinary interventions by the Federal Reserve and Treasury? I suspect it’s huge, and if so, it bodes poorly for the next several years.

Irwin also raises the critical point of consumer spending. It has collapsed in this recession despite weathering the 2001 downturn pretty well. That’s because much of the spending was built on illusory wealth. Think of all the home equity lines of credit that cashed out equity to pay for college or new cars.

Check out this excellent post by the NYT’s Floyd Norris at his blog listing the monthly percentage declines in consumer spending over the past year.

In July—and remember that’s the first month of the third quarter, which is supposed to be the one that returns us to GDP growth—consumer spending got crushed, down 5.9 percent. It would have been far worse but for the cash-for-clunkers program, yet another government program goosing the economy:

But it turns out that all of that improvement comes from a modest increase in auto sales, caused by the “cash-for-clunkers” program. Retail sales excluding cars and gas were down 5.5 percent in July from a year earlier — the largest monthly decline yet.

Consumer spending accounts for more than seventy percent of the economy. You’re just not going to really have recovery until consumers stop sitting on their wallets. But the problem is, those wallets are pretty thin. Trillions of dollars in equity in their homes and stocks have evaporated. Wages are declining. One in six Americans can’t find full-time work. One in ten can’t find any at all. Many of those have been out of work for so long their unemployment benefits are about to expire. What are they going to spend? But the larger point is, for the long-term health of the country, consumers need to save more and spend less anyway. The old economy was unsustainable and structural changes are wrenching.

Another problem, as the Post notes, is that the Fed will have to raise interest rates from zero at some point. That will crimp any potential future growth.

The thing about this story is the situation is even worse than it portrays. There are some serious things missing here, including a nod to the fact that we haven’t really done anything about all the toxic assets on banks’ balance sheets besides let them pretend they’re worth more than they are. The Post touches on commercial real estate but doesn’t really say its collapse is about to go full bore (Fitch predicts up to 15 percent of hotel CMBS, for instance, will be delinquent by year’s end. And it doesn’t mention the ever-rising residential foreclosures, up 32 percent in July from an already high base last July.

But it’s a welcome reality check.

UPDATE: I should note that Irwin’s piece was published yesterday, before stock market tumbles gave the press an easy news peg on the sustainability of any economic uptick—something it should have been on regardless of the market’s direction.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.

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